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Investor Beware

Investor Beware

This article was originally posted on Susquehanna Style. 

Written by: Bradley R. Newman, CFP® Senior Investment Advisor & Director of Financial Planning

Not all financial advisors are created equal.

Investor Beware Registration

Many financial professionals carry the title ‘advisor’ yet follow a traditional sales business model; mainly getting paid through earning commissions from the sale of a product or collecting bonuses from meeting sales quotas. A conflict-of-interest arises because the advisor has an incentive to recommend products with the highest commission or because they are under pressure to meet a sales quota. Think of these financial advisors like a pharmaceutical representative whose job it is to sell a specific drug.

Contrast this with an advisor who operates as a fiduciary and sells no products. They operate under a duty of care and loyalty that puts the clients’ best interests above the advisor.  Think of the doctor whose job it is to diagnose the issue and work with the patient toward a cure.

The doctor must follow the Code of Medical Ethics to offer the best solutions for the patient. The pharmaceutical rep is a salesperson with no Hippocratic oath requirements. The same relationships exist in the financial world, but how do you decipher whether you are working with the doctor or the pharmaceutical rep?

Solutions that are merely suitable, versus solutions that are in your best interests.

Terms like a ‘Fee-Based,’ ‘Dual Registered,’ and ‘Independent’ financial advisor are commonly misunderstood and misrepresented. Advisors operating under these business structures often have the ability to work as a broker-dealer and are therefore held to a lesser ‘suitability standard’. For Example, instead of having to place the client’s interest first, the advisor must merely believe the recommendation is ‘suitable’.

The vital distinction in these standards is that when acting under a suitability standard, the advisor’s duty is to the brokerage firm that he or she works for, not necessarily the client served. In these situations, the burden is on you, the client, to determine the standards being used by the advisor for each recommendation made. Many of these advisors can be held to a fiduciary standard in certain situations, but they have no obligation to tell an investor when that is.

By comparison, only a Fee-Only Registered Independent Advisor (RIA) works exclusively under a fiduciary standard and is legally required to put your financial best interests first. What kind of a difference can this make? Let’s say there are two large-cap stock funds which are identical, except Fund A charges a 1% expense ratio and Fund B charges 4% expense ratio.  While both funds may be considered “suitable” only a Fee-Only RIA is obligated by a fiduciary duty to recommend Fund A.

 What About Wealth Managers?

Job titles such as ‘wealth manager,’ ‘money manager,’ and ‘financial advisor’ are not professional designations. Again, only Fee-Only Registered Investment Advisor (RIA) firms have a fiduciary relationship that legally obligates the advisor to put their clients’ interests first. There are no potential hidden charges, or product biases associated with the investment services or advice that a client received from a Fee-Only RIA. Fee-Only RIA firms are driven by client success – not by sales quotas.

Don’t Fee-Only advisors cost more?

The “cost” of working with financial advisors is a relative term. Most financial advisors start the conversation with security selection, which means picking and selling the client a financial product.  Why do they focus on security selection?  Because they are paid according to what product they sell you. While you may not pay a direct fee to the advisor, you are paying a percentage of your initial, and possibly ongoing, investment in the form of commissions to the advisor. The disparity does not end there. There are over 9,000 mutual funds to choose from, and these fund returns can vary drastically.

Since a Fee-Only RIA is not concerned about compensation for selling the fund, they will begin with a due diligence review to determine the quality of the recommended fund; for example, they will examine how did a fund rank compare to its peers. But how does this impact investment returns? To start to answer these questions, let’s look at just the 1,349 Large Cap Growth Funds of 2017 in “quartiles.” Quartiles mean that we break their performances down to 4 segments or quartiles, starting with the top performing 25% as compared to the bottom performance 25%. As shown below, while the funds are in the same peer group and have relatively similar levels of risk, the monetary impact to the investor was +12.33% difference for one year, in this example. *

 

*Source: Morningstar Direct 12/31/2017 & Statista 2019 — The data in this chart is an illustration of the performance difference over a discrete time frame for similar funds as grouped and ranked by Morningstar.  It is not representative of the advisor’s returns for the timeframe and is also not indicative of the advisor’s ability to consistently choose such funds.  Past performance is not indicative of future results.

Be your own advocate.

Regardless of your advisor’s compensation model, be sure that you understand how their compensation is being derived and that you get the terms outlined in a clearly written statement. If you have even the slightest concern, seek a second opinion. Many Fee-Only RIAs, like Roof Advisory Group, will offer a complimentary consultation for qualifying investment portfolios. Make sure your money is working to its fullest potential so that you can rest assured that you are creating a path to a meaningful life, stable wealth, and a lasting legacy.

 

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